Big Banks’ exodus from Commodities

Goldman Sachs, Morgan Stanley, Barclays and JP Morgan used to be the biggest traders of commodity among banks. However, this space has witnessed many of the big banks exiting the business line in recent times. JPMorgan recently decided to exit physical commodities trading business by selling its raw-materials trading unit to Mercuria Energy Group Ltd. Morgan Stanley decided to sell its physical oil business to Russia’s Rosneft. Barclays decided to exit some of its commodities business. Deutsche Bank said it would exit dedicated energy, agriculture, dry-bulk and industrial-metals trading. Bank of America Corp. said it would dispose of its European power and gas inventory. UBS decided to shrink its commodities business sharply. Goldman began a process to sell part of its physical trading operations. This retreat of the big banks from commodity business has been driven by tighter regulation, stricter capital requirements, increasing political pressure and lower profitability in recent times. Key regulations impacting banks in commodity trading include Basel III, Dodd-Frank, and the Volcker Rule. Rules brought in to address the financial crisis of 2008 (Basel III, Dodd Frank) require banks to hold more capital than in the past against trading operations, which has made holding commodities more expensive for the banks. New charge for credit valuation adjustment (CVA) – which requires higher charge for longer dated trades with lower rated counterparties – is likely to have significant impact on hedging practices of longer dated trades. Further, regulators are pushing for over the counter trades to the public exchanges, which is likely to significantly reduce profitability of such trades for the banks. Volcker rule, aimed at banning banks from trading with their own capital, is another catalyst in this regard. Anticipating this rule many banks have already scaled back or spun off their proprietary trading desks. Politicians have also exerted pressure on banks to cut back their commodities business. Regulators and some senators have expressed concerns about banks being in the business of natural resources. This has been largely prompted by events like Deepwater Horizon oil spill, complains from other industries and associated media coverage. Policy makers are now seeking comment and exploring ways to limit banks’ role in trading of commodities.The U.S. Federal Reserve is considering new limits on trading and warehousing of physical commodities. Policy makers suspect that there are conflicts of interest when the same entity is involved in the physical market and also in trading derivatives on the same underlying. Commodity Futures Trading Commissions (CFTC) is investigating the effect banks are having in the commodities markets, as it has been argued that banks played a major role in the rising commodity prices, including that of agro-prices, in the latter part of the last decade. Lacklustre market conditions are another driver behind many banks’ decision to shrink or wind up their commodity business. While regulatory burdens have added to cost side of the business, less volatility in commodity prices have hit top line. Combination of these factors has resulted in lower revenue from the business. Industry estimates suggest commodity-trading revenue for the ten biggest banks shrunk by over 67% in 2013 compared to peak levels attained in 2008. This trend of falling revenues holds good for not only the commodity business, but also to the FICC (Fixed income, currency and commodity) segment in general. Forced by this, some banks are shrinking or winding up their Fixed Income business as well. These developments are making commodity trading an inefficient use of capital at a time when other markets, such as equities, are showing signs of recovery.
Arin Ray About Arin Ray

Arin Ray is an analyst with Celent's Securities & Investments practice and is based in the firm's New York office. Arin's expertise lies in capital markets where he has extensive research experience in exchange trading, clearing and settlement, brokerages, and use of technology in capital markets. In his recent consulting work, he has advised a large European financial services provider to devise their post trade (settlement) strategy, a tier 1 Japanese brokerage in their product and technology strategy, and a leading international exchange in their market entry and growth strategy in Asian markets. He has published research reports on exchange and over the counter trading, exchange strategies, and adoption of trading technology in different sub-segments of capital markets.

Arin has been quoted regularly in the media, including Reuters, Wall Street Journal, Financial Times, Dow Jones, Press Trust of India, Economic Times, Financial Express, Finance Asia, Global Investor Magazine, BusinessWeek, Business Standard, Asian Investor, Pension & Investment, Business Week, and Securities Industry News. In addition, he regularly contributes bylined articles for the financial media; his articles have appeared in The Journal of Trading, Advanced Trading, Free Press Journal, FT Asian Investment, gtnews, and Ignites Asia among others.

Arin received his MBA from the Indian Institute of Management, Bangalore and B.E. in Electronics and Telecommunication Engineering from Jadavpur University. He is fluent in English, Hindi and Bengali.

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